This is a post in progress and I plan to update/improve it constantly over time to serve prospective and new subscribers.
This is an explanation of how to use the trade ideas generated by “The Box.” Every night subscribers receive a spreadsheet via email that details the trade ideas for the following day. Here’s a screenshot of a portion of the spreadsheet sent on February 20, 2008. Let’s walk through each of the rows to figure out all this information:
1) Index: this row tells you which index the stock belongs to, in this case Honeywell (HON) belongs to the S&P 100 index, or OEX.
2) Trade # in month: HON is the 29th trade idea generated in the month of February 2008.
3) Date FOR: this is the date the trade is for … each trade is good for only one day, in this case the trade is good for February 21, 2008 and no other date.
4) Symbol: the ticker symbol; in this case HON stands for Honeywell.
5) Long / Short: this tells you if the trade is a long (buy) or a short (sell short); in this case the trade is a long.
6) Entry above (long) / Below (short): this is the price level above which you should set your buy limit order or below which you should place your sell (short) limit order. I usually put my stop limit order one to five cents beyond the entry level. You should also read the post, Dealing with Gap Openings, for other thoughts on entry.
7) Initial Protective Stop: this is the all important price level below which you should set your stop order when long and above which you should set your stop order when short. Once you are filled in a trade, you must always Always ALWAYS immediately put your stop order in the market. Did I mention you should always immediately do this? :)
8) Initial Risk $: this is the approximate amount between your entry price and your initial protective stop. We use this number to size our position (more on position sizing below).
9) Initial Risk %: this is the approximate percentage amount between your entry price and initial protective stop. This is a key number because our minimum expected percentage gain (Target 1.0, see below) must be a multiple (at least two times and preferably more) of our maximum percentage loss. Before considering any trade you always Always ALWAYS think about risk versus reward.
10) 100% Initial Risk: this is the price that approximates one times our initial risk; once price closes beyond this level we move our initial protective stop to our entry price to create a breakeven trade at worst.
11) 200% Initial Risk: this is the price that approximates two times our initial risk; following the ABC Stop Method (more here), once price closes beyond this level we begin to trail the stop.
12) Target 1.0: this is the minimum expected price target
13) Expected % move: this is the minimum expected percentage move from the entry price to Target 1.0.
14) Expected R move: “R” is a fancy way to say “initial risk.” In the example, HON’s initial Risk % was 2.39% and the expected % move was 7.75%. 7.75% divided by 2.39% is approximately 3.2.
12) Target 1.1: this is the maximum expected price target
13) Expected % move: this is the minimum expected percentage move from the entry price to Target 1.1.
14) Expected R move: Again, in the example, HON’s initial risk % was 2.39% and the expected % move was 9.55%. 9.55% divided by 2.39% is approximately 4.0.
Position Size: We always risk the same dollar amount on every trade. How much you’re willing to risk depends on how much risk capital you have. I recommend that the dollar amount at risk on a single trade should be a fraction of 1% of your risk capital. Risk capital means money you can afford to lose, your “mad money,” the money you can lose and not worry about it. If you’re worried about money, you shouldn’t be trading in the first place. If you have $100,000 risk capital, then I’d recommend risking around $250 (one quarter of one percent of risk capital) to $500 (one half of one percent of risk capital) on a single trade.
Going back to HON, you can see that the initial $ risk is $1.35. Ignoring commission costs (which should be very very low), let’s assume you’re willing to risk $270 on the trade (representing 0.27% of your risk capital) so you can get long 200 shares (200 x $1.35 = $270). 200 shares of HON at 56.53 is around $11,600.
Now let’s look at the charts. Here’s the chart from Wednesday, February 20th, when the trade idea was first sent out. I’ve annotated the chart with all the key levels.
On Thursday, February 21st, you can see that price traded above the entry level which would have triggered the stop limit order to get long above 56.53. The stock closed down on the day and things looked ugly, but the initial protective stop in place below 55.18 was not hit.
On Friday, February 22nd, the stock reversed and closed up on the day, never hitting the initial protective stop order that is always in place.
The following Monday, February 25th, HON shot higher and touched 57.88, the 1x Initial risk level. Once the 1x level is hit, we can move the initial protective stop from 55.18 to our entry price around 56.53, thus assuring a breakeven trade if price reverses back down.
Finally on Tuesday, February 26th, HON moved up strongly again, coming within one cent of hitting the 2x Initial risk level of 59.23. You could choose to begin trailing the stop here if you wished, or wait down below at the breakeven stop — it’s a judgment call. I’m still studying the best way to exit these trades.
One new idea I’ve had is not to trail the stop until the Target zone is reached, with a breakeven stop in place the whole time. Dunno… I’ll continue to observe and test.
Anyway, I hope this short introduction is useful. I plan to update and improve this post over time, but I just wanted to put something up fast for my dozen new subscribers to study. :)
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